Ferrous scrap market unpredictable despite consolidation

ggressive consolidation by domestic steelmakers to lock up scrap supplies has resulted in producers capturing a large portion of the overall pie, so it is something of a mystery as to why mills are still subject to volatility in the market.

When the asset buying spree really built up momentum in 2008, some industry players suspected that steel producers would be able to manipulate the ferrous scrap market because they had their hand too deep in the cookie jar. Time has proven this premise wrong as the fickle scrap market clearly continues to do whatever is pleases. Scrap prices illustrate the point. No. 1 heavy melting steel scrap averaged $417 per ton last year compared with $357 per ton in 2008, according to Brad Macaulay, a Metal Bulletin Research analyst.

Before 2008, producers like Nucor Corp. and Steel Dynamics Inc. (SDI) decided to take the next step and actually married their long-time scrap suppliers in megadeals that came with upward of 10-digit price tags. Ferrous scrap costs are the largest input cost by far for electric furnace (EF) steelmakers, and producers were quick to snatch up assets as a strategy to better manage supply.

In addition to Charlotte, N.C.-based Nucors buy of David J. Joseph Co. and SDIs acquisition of OmniSource Corp., the producers have continued their sweep of scrap asset buys and add to their arsenal.

The U.S. scrap market reached 81.5 million tons in 2010, according to the Institute of Scrap Recycling Industries, Washington, and regulatory filings reveal that producers were brokering or processing 19.6 million tons.

No single scrap recycler holds a significant domestic market share, but as a collective group its buying power cant be denied. The price to feed the mills seems to have less to do with mill ownership and more with a plethora of other factors. In other words, there are greater factors that the U.S. producers cant decouple from despite a healthy ownership.

Mill utilization rates, export demand, service center buying patterns and the strength or weakness of the U.S. dollar seem to overshadow the producers stronghold on scrap assets.

According to 2010 annual reports (the most recent available as of press time) filed with the U.S. Securities and Exchange Commission (SEC), Nucors annual scrap processing capability approached 5 million tons and it consumed 17 million tons; Fort Wayne, Ind.-based SDI processed or brokered 5.2 million tons and consumed nearly 4.8 million tons; Commercial Metals Co., Irving, Texas, shipped 2.1 million tons; and Schnitzer Steel Industries Inc., Portland, Ore., processed or brokered 5.3 million tons. And Gerdau Long Steel North America, part of Gerdau SA, has 17 scrap recycling facilities that collect, sort and process some 2 million tons each year, according to its website.

So the question remains: With so much scrap under producers control, why is the market more volatile than it has ever been?

The scrap market will always be impacted by mill utilization rates and any downturn in demand is driven by the state of the economy2009, which is an anomaly because of the anemic demand that drove operating rates to 50-plus-year lows, illustrated that pricing and mill operating rates go hand in hand. Mill rates averaged 51 percent in 2009, when the average No. 1 heavy melting steel scrap price was $217 per ton. As the recessionary environment subsided and manufacturing improved last year, the amount of prompt industrial scrap generated rebounded, putting downward pressure on prices in the first two months of 2012.

Another factor out of anyones control is that scrap is a global commodity enormously influenced by worldwide demand. The size of the U.S. scrap export market is on par with that of the domestic mills assets, and offshore customers demand impacts the price.

The United States is the worlds largest exporter of ferrous scrap, shipping more than 24 million tonnes to nearly 90 countries last year, up from 20.5 million tonnes in 2010. When offers from Turkey, a large customer, go cold and shipping opportunities dry up, export scrap moves inland and begins to oversaturate the domestic market.

It is common knowledge that export-grade scrap is a lesser-quality material. There is an adage among scrap players that if it sinks and sticks to a magnet, it is good enough to ship. U.S. producers are far more selective about the metallurgical quality of scrap bought, although they are known to buy material that was initially earmarked for export when the price is right.

The volatility is so rapid and unpredictable that it has thrown all the old rules out of the window. Historically, scrap prices eased in the spring months and stayed steady until at least November as mills laid down material to prepare for the onslaught of ice and snow. This forecasting mechanism, which had been trusted and dependable for a century, is no longer true, with recent movements showing that the market does as the market chooses.

Aside from mill operating rates and global demand, the U.S. dollar is another factor that meddles in the scrap market. When the dollar gains steam, it works against the scrap market.

A strong U.S. dollar would make our products more expensive for non-U.S. customers, which could negatively impact export sales, Schnitzers fiscal 2011 annual report said. Compounding this, a strong dollar also makes imports less expensive and results in an increase in imports of scrap metal and its substitutes, which can pressure domestic prices.

This was readily apparent in 2008, when the weak dollar and strong global demand sent scrap selling prices to unprecedented levels.

The timing and magnitude of the cycles in the industries in which we operate are difficult to predict and are influenced by different economic conditions in domestic (where we typically acquire our raw materials) and foreign (where we typically sell a significant portion of our products) markets, Schnitzers annual report said.

Service centers also contribute to scrap price trends. Lean inventories are now embraced and the optimal three-month supply on hand is no longer the benchmark. Even when mills are running full out, distributors choose to be conservative with the volume of finished material in their warehouses. This leads to a perpetual but muted demand.

Mills are opting to keep lower inventories at their melting facilities as well. Whereas it was once common to have 30 days of feedstock at the mill, during slow periods a 10-day supply is considered the norm.

EF producers in particular have a strong motivation to try to keep scrap prices in check, since they rely more heavily on the material than integrated mills. Most integrated mills have secured raw material positions in metallurgical coal and iron. When scrap prices overheat, the integrateds can become lower-cost steel producers.

Not only do steelmakers own scrap assets, they have taken a keen interest in purchasing sizeable volumes of the largest source of obsolete scrap, auto salvagers, which are a major provider of vehicles to shredders. It seems when prices get too low, mills could order their salvage operations to stop sending cars to the shredder in order to tighten up supply and bolster prices. Mills could indirectly control the flow, although in reality this doesnt occur.

They (mills) have become very powerful because they hold the cars that become feed for the mill, one scrap dealer said.

The auto dismantling business is still highly fragmented and mills dont own enough of these to control the (used auto parts retail sales operations), one broker said.

Industry players and observers differ in their assessment. I have felt there is a high level of conflict of interest with the mills owning scrap assets. But they still havent realized that when they bring down the price of scrap they have to lower the price of steel, an industry player said.

A second broker noted that mill ownership of scrap assets hasnt been the magic bullet to stem volatility. This type of control was supposed to give less volatility in the market and I dont think it has worked, he said. We thought it was game over in 2008, and 2011 ended up being the highest-price year.

Another broker disagreed, noting that the mills use their brokerage houses and ability to buy in quantity to dampen the prime scrap market.

The merged scrap and steel companies are having an effect on the market, the first broker said. After the integration, they began to take advantage of dips in the market and buy pig iron when the market is at bottom to keep a lid on prime scrap prices.

The mills give the pig iron to brokers to sell to competitors and control the flow of scrap, the second broker added.

Mills continue their quest to increase their market share of scrap assets through acquisitions and organic growth. But while vertically integrated mills can be assured of a captive scrap supply, there are no signs on the horizon that it can impact scrap prices.

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